Your weekly economic update from the team at FXD Capital
Last week saw some relative drama with the Federal Reserve moving forecasted rate increases forward and revising its inflation forecasts upwards. The typical response expected from markets would be:
- Bond Yields: Rise
- Stocks: Fall
- Emerging Market Currencies: Fall
In reality, only the latter has followed the script. Yields are lower than a week ago, and stocks have since rallied despite initial falls. Erratic asset performance is reflective of the uncertainty surrounding policy decisions. When news is released, rationally speaking, we would expect prices to follow the textbook response. In reality, every week brings new data and commentary, which contracts previous expectations.
Perhaps at the root of it is the failure of central bodies to produce accurate forecasts. Obviously, as the name suggests, a forecast is just an informed punt, but the inability of central bodies to attribute why predictions are so far off the mark leads to market uncertainty. As with political election results often being markedly different from pollsters’ pontifications, the schism between expectations and reality is causing many to go it alone and follow their intuition. Hence, we have market behaviour more akin to a flea market than an orderly supermarket queue.
One exciting piece of news from debt markets came from Argentina, with word of it striking a deal to avoid default on $2.4bn in July. In agreement with a group of creditors – the Paris Club – Argentina gained a reprieve until next March to finalise restructuring terms. Why is this important? Emerging market countries are arguably those with the most to lose over the long term from Covid. Their public health infrastructure is weaker, economies more co-depended on others, and vaccine access spottier. The threat of a sovereign debt crisis in the EM region is real, and you already see several countries circling the drain. Colombia is a prime example, where protests manifest as its government wrestles with spending cuts to protect its investment-grade credit rating.
In its latest statement, the BOE’s Monetary Policy Committee said it expected inflation to sit above 3% for a “temporary period”. A full quorum of 9 members voted to maintain the base rate at 0.1%. Transitory is the new buzzword of choice in central bank economics, and the BOE did not disappoint by also attributing it as the reason behind recent price spikes.
Caution remains whether the current bounce back being experienced will turn into a boom or reside back to normalcy. The BOE noted that June output is forecasted to be 2.5% below its pre-Covid level. Interestingly, the committee acknowledged that the delay of the June 21 final lockdown relaxation phase would not have a material impact on the economy: which seems rational for what is primarily a ceremonial moment of closure, more so than a shift (apologies to any nightclub owners).
The US, UK and EU all seem to be moving in a synchronised fashion. Whatever happens in the US occurs a month later in the UK, followed down the line in the eurozone.
The Federal Reserve loosened restrictions on dividends and share buybacks imposed on banks during the 2020 crisis. Analysis released showed lenders could suffer almost $500bn of losses and still meet capital requirements. Twenty-three banks passed stress tests, and the release of restrictions will be a boon to bird-in-the-hand philosophy shareholders, who prefer the stable income of bank stocks.
Banks are still looked at through a subprime-esque lens, which exposes them to very conservative restrictions over capital usage. While securitisation still exists, bank activities now are more binary – either through direct lending or brokering transactions. Both result in fewer hidden risks and capital rules in place ensure large buffers are in place.
The median price for US houses rose 23.6% on the year, which is a staggering statistic for a country as vast as the States, with a less urban-centric way of life. Perhaps as a harbinger to the enthusiasm, sales numbers are declining, and inventory rising, indicating that while the value of houses is going up, it’s now at the frothy stage where fewer are biting at the cherry.
It all leaves the Fed in an awkward position. Raise rates to tame inflation, but kill the housing market? Or vice versa. I think they will try to obfuscate inflationary effects as much as possible to kick the can further down the road.
Germany is forecast to borrow an additional €100bn next year, up €18bn on previous estimates. While Germany is in the envious position of having some of the lowest yields globally, the borrowing effects of eurozone countries in unison will be interesting to see on spreads between the bloc’s nations.
European house prices are seeing similar conditions to those of the States. An ECB report from Q4 2020 showed house prices in the bloc increasing 5.8% on the year, the fastest pace since 2007. The space-constrained Netherlands leads the charge, up 12.9% in May on the year, its most rapid growth since 2001. Like in the US, property sale numbers are declining. Spain is the only major global country to see house price declines on the year.
All the best for the week ahead
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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